Chip, not only Nvidia: Cadence runs on artificial intelligence on the stock exchange

Considering the five-year time frame, the rise is 390% while, over the 10-year period, the performance is over 1.930%. True! Several other stocks in the chip sector can boast similar trends. And yet, the stock market trend itself indicates that Cadence's dynamics cannot be filed under: 'sporadic' events.

All as easy as drinking a glass of water, then? The reality, as always, is more complicated. The proof is in the speed of revenue growth. Cadence had an expansion rate of 22% in 2022. Last year it dropped to 15%. Finally: the outlook for 2024.

The group expects the increase to be around 12%. In short: there is a slowdown in the speed of the rise. Of course: the chip sector, according to Omdia, dropped by 9% in 2023. More specifically, then, electronic design automation (Eda) - Cadence's main target market - is estimated to have a weighted average annual growth rate (CAGR), between 2023 and 2033, of 8.6%.

That is to say: the group has done, and should do, better than both the semiconductor world and its industry. Not only that. To the objection on the prospects for expansion in 2024, the management replies that what matters - in the face of the fact that its contracts last on average three years - is the three-year CAGR. An indicator - the company points out - that has been rising steadily since 2017, reaching over 15%. Which, is the implicit conclusion, must be considered an important performance.

Having said that, however, the basic objection remains valid. Not least because, it must be remembered, the valuation (e.g. by means of a multiple such as the price-earnings ratio, the P/e) of a high-growth stock - such as that of Cadence - is very much influenced by expectations of business growth. All the more so when this is not at a discount.

According to Seeking Alpha's database, the forward-looking non-GAAP P/e on 2024 is 52.4 times. This is higher than the industry average and that of a direct competitor such as Synopsys (42.5). The same Peg - i.e. the price-earnings ratio normalised to annual profit growth estimates in the medium to long term - is 3.33 times. A figure that, again, is higher than the industry average and that of Synopsys (2.32). In short: the indication is that the do-it-yourselfer must use caution, and be careful, especially with regard to the growth dynamics of both turnover and profitability.

But it is not just a question of multiples (with respect to which, moreover, it is always necessary to refer to more indicators than just P/e). Another focus, on the one hand, is to understand the activity of the company in question; and, on the other, to deduce the reason for the interest on the part of the stock exchange. Well, Cadence has, precisely, the so-called Eda as its reference market.

Namely: the automatic design of the architecture of hi-tech solutions. In general, the company produces software and platforms to design, simulate, and assemble electronic and semiconductor systems. More specifically, the company divides its revenues by product categories. Well: at the end of 2023, the areas that generated the most sales (27%) were 'Digital IC Design and Signoff' and 'Functional Verification, Including Emulation and Prototyping Hardware', respectively.

The first segment covers products and services dedicated to the design and final verification of digital integral circuits (Signoff is the stage where the chip is validated at the level of technical and production requirements).

In the second area, however, there are various activities: from the use of hardware to simulate the behaviour of the electronic solution to the creation, thanks to hi-tech platforms, of the physical version of the integrated circuit design. In addition to software for the design of custom semiconductors ('Custom IC design', worth 22% of turnover), the world of IP (pre-defined design blocks) and system design (not individual microprocessors) should also be mentioned, both of which are worth 12% of last year's turnover.

With such an articulation of business, it is easy to understand why Artificial intelligence (AI) - which requires ever more powerful, efficient and faster chips - has given the accounts a boost, with the blessing of the stock exchange.

The need for large manufacturers of microprocessors for AI to develop cutting-edge technology has facilitated demand for Cadence's products.

So it is no coincidence that the company has the likes of Nvidia, Intel or Arm as customers. These are companies that allow Cadence to participate in the Artificial Intelligence super cycle. A trend that, according to the company itself, the group exploits in three ways. The first is to provide the tools to create the AI infrastructure. The second - Cadence always indicates - is the introduction of Artificial Intelligence into its products (e.g. Cerebrus for automatic design). The third, finally, is the application of the new algorithms to areas such as the biosciences. A context in which the market that can be attacked by Cadence is expanding, and not by a little.

However, the saver points out that competition in Eda is very strong. Cadence has the second position, behind Synopsys, by market share and the battle for orders is fierce.

For this reason, too, the group has made several acquisitions. Just at the beginning of March there was the shopping spree, for USD 1.2 billion, of Beta Cae. In January, on the other hand, it was the turn of Invecas.

Not forgetting, among others, the M&A on Rambus (IP sector) in 2023. These are moves which, on the one hand, aim to expand the portfolio offering; but which, on the other hand, inevitably carry execution risk.

True! Cadence has, over the years, performed over 60 extraordinary operations. So it has experience in integrating new realities. Having said that, however, synergies must still be realised.

Also because - but this applies to all players in the industry - it should not be forgotten that the hi-tech war between Washington and Beijing is an ever-present sword of Damocles. The moment, for instance, there was escalation over Taiwan, Nvidia's business would be affected.

And with him that of Cadence. If this is the general context, what then is the outlook for the business in the current quarter? The company expects revenues to be in the range of 990 to 1,010 million. Earnings per share (not GAPP), on the other hand, should be in the range of $1.1 and $1.14.

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